Has Gary Gensler and the SEC Gone Crypto Crazy?

U.S. regulators and the SEC were busy in February, doling out headlines and enforcement actions seemingly every couple of days. This includes 

• A joint statement by the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the Treasury’s Office of the Comptroller of the Currency (OCC) that strongly discourages banks from engaging with cryptocurrencies. The statement recognized that banks are not prohibited from offering services to any type of customer, including those involved in the crypto industry. However, the regulators also highlighted the particular risks associated with crypto-related companies and assets, cautioning banks against holding or issuing cryptocurrencies as principal. They also pledged to closely monitor exposure to crypto assets.
• The Board of Governors of the Federal Reserve System recently released a policy statement on crypto activities and state-chartered banks, following a joint statement by banking regulators about the risks associated with crypto assets for the banking system. The policy statement aims to create a level playing field for state-chartered and federally-chartered banks, and it denied Custodia Bank's application to join the Federal Reserve System. The statement clarifies that neither national nor state-regulated banks have the authority to hold crypto assets as principal, which means they cannot hold crypto as an investment asset on their balance sheets. While issuing stablecoins is "presumptively unlikely" to align with safe banking practices, the Board did not entirely rule it out. The Board also highlighted the importance of verifying parties transacting with banks, including unhosted wallets, and noted that banks can custody digital assets in a regulated, safe, and sound manner.
• The SEC ordered Paxos to stop issuing BUSD. The New York Department of Financial Services (NYDFS) has ordered Paxos Trust Company, the issuer of the BINANCE USD (BUSD) stablecoin, to cease the creation or minting of new tokens. This move comes amid the controversy surrounding the BUSD stablecoin, also known as the Binance USD, and Paxos' announcement of its intention to end its relationship with Binance. The reason for the halt is unclear, but it may be related to the issuance of BUSD on other blockchains, known as Binance pegged BUSD, which was not approved by the NYDFS. Concerns have been raised about BUSD, including allegations of insufficient backing for pegged assets, comingling of client funds, and attempts to create an interest-paying stablecoin.
• Additionally, the SEC sent a Wells notice to Paxos, suggesting that the agency may take action against Paxos, the issuer of the stablecoin BUSD. Although the notice is not public, Paxos confirmed that the SEC considers BUSD to be a security, and that its offering was not registered under federal securities law. However, Paxos has publicly disagreed with the securities classification. Additionally, the NY DFS ordered Paxos to halt the creation of new BUSD tokens, and Paxos announced its decision to sever its ties with Binance. It is unclear why the DFS halted the issuance of BUSD, but it may be due to the issuance of Binance pegged BUSD on other blockchains, which was not authorized by the DFS. Paxos's competitor, Circle, has not received a Wells notice from the SEC and issues the second largest stablecoin, USD Coin (USDC).
• The SEC recently filed a complaint and settled with Kraken over its staking-as-a-service offering, with Kraken agreeing to pay a $30M fine and end the service. This marks the first enforcement action against staking services triggering securities regulation, although the underlying assets used to stake are not considered securities. SEC Chairman Gary Gensler has previously expressed concern about staking services, and COINBASE has now published a blog post stating that its staking services are not securities. While Ethereum has transitioned to proof of stake, many newer cryptocurrencies also allow owners to generate returns by participating in the block-building process.
• The SEC has filed charges against Genesis and Gemini Earn for their involvement in the unregistered sale of securities to retail investors in the aftermath of the bankruptcy of Genesis' lending arm, which impacted users' balances in the Gemini Earn program. According to the complaint, the Gemini Earn program, in conjunction with Genesis, constituted an offer and sale of securities that should have been registered. In addition, the SEC has charged Terraform Labs and its CEO with fraud in relation to the sale of crypto asset securities Mirror (MIR), Terra (LUNA), and Terra USD (UST). The SEC alleges that MIR, marketed as a "governance token" for the Mirror Protocol, and UST, an algorithmic stablecoin, are both securities.